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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
______________
FORM 10-K
FOR FISCAL YEAR ENDED DECEMBER 31, 1997
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 (FEE REQUIRED)
For the fiscal year ended December 31, 1997
OR
[_] TRANSITION REPORT PURSUANT TO THE SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
For the transition period from to
Commission file number: 1-8972
INMC MORTGAGE HOLDINGS, INC.
(DBA INDYMAC MORTGAGE HOLDINGS, INC.)
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 95-3983415
(STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER
OF INCORPORATION) IDENTIFICATION NO.)
155 NORTH LAKE AVENUE, PASADENA, CALIFORNIA 91101-1857
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
Registrant's telephone number, including area code: (800) 669-2300
Securities registered pursuant to Section 12(b) of the Act:
NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
------------------- ----------------------
COMMON STOCK, $.01 PAR VALUE NEW YORK STOCK EXCHANGE
Securities registered pursuant to Section 12(g) of the Act: NONE
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days. YES X NO ___
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Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K [_].
As of March 23, 1998 there were 65,082,991 shares of INMC Mortgage
Holdings, Inc. Common Stock, $.01 par value, outstanding. Based on the closing
price for shares of Common Stock on that date, the aggregate market value of
Common Stock held by non-affiliates of the registrant was approximately
$1,540,256,840. For the purposes of the foregoing calculation only, in addition
to affiliated companies, all directors and executive officers of the registrant
have been deemed affiliates.
DOCUMENTS INCORPORATED BY REFERENCE
PROXY STATEMENT FOR THE 1998 ANNUAL MEETING---PART III
INMC MORTGAGE HOLDINGS, INC.
(dba , IndyMac Mortgage Holdings, Inc.)
1997 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
Page
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PART I
ITEM 1. BUSINESS...................................................... 1
ITEM 2. PROPERTIES.................................................... 14
ITEM 3. LEGAL PROCEEDINGS............................................. 14
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS........... 14
PART II
ITEM 5. MARKET FOR THE COMPANY'S STOCK
AND RELATED SECURITY HOLDER MATTERS........................ 14
ITEM 6. SELECTED FINANCIAL DATA....................................... 15
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS........................ 16
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA................... 27
ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.......... 27
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT............ 28
ITEM 11. EXECUTIVE COMPENSATION........................................ 28
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
OWNERS AND MANAGEMENT...................................... 28
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS................ 28
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND
REPORTS ON FORM 8-K........................................ 29
PART I
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ITEM 1. BUSINESS/1/
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GENERAL
INMC Mortgage Holdings, Inc., dba IndyMac Mortgage Holdings, Inc. ("IndyMac
REIT"), was incorporated in the State of Maryland on July 16, 1985 and
reincorporated in the State of Delaware on March 6, 1987. INMC Mortgage
Holdings, Inc. commenced using the dba IndyMac Mortgage Holdings, Inc. ("IndyMac
REIT"), effective January 1, 1998. IndyMac REIT will seek approval from its
shareholders to formally change its corporate name to IndyMac Mortgage Holdings,
Inc. at the annual shareholders meeting scheduled for May 19, 1998. References
to "IndyMac REIT" mean either the parent company alone or the parent company and
the entities consolidated for financial reporting purposes, while references to
the "Company" mean the parent company, its consolidated subsidiaries and
IndyMac, Inc. ("IndyMac Operating") and its subsidiary, which are not
consolidated with IndyMac REIT for financial reporting or tax purposes. All of
the outstanding voting common stock and 1% of the economic interest of IndyMac
Operating is owned by Countrywide Home Loans, Inc. ("CHL"), which is a
subsidiary of Countrywide Credit Industries, Inc. ("CCR"). All of the
outstanding non-voting preferred stock and 99% of the economic interest of
IndyMac Operating is owned by IndyMac REIT. Accordingly, IndyMac Operating is
accounted for under a method similar to the equity method because IndyMac REIT
has the ability to exercise influence over the financial and operating policies
of IndyMac Operating through its ownership of the preferred stock and other
contracts. IndyMac REIT has elected to be taxed as a real estate investment
trust ("REIT") under the Internal Revenue Code of 1986, as amended (the "Code").
As a result of this election, IndyMac REIT will not, with certain limited
exceptions, be taxed at the corporate level on the net income distributed to
IndyMac REIT's shareholders.
The Company conducts a diversified mortgage lending business, including the
origination and purchase of and investment in non-conforming and jumbo
residential loans, subprime loans, manufactured housing loans, home improvement
loans, mortgage-backed securities and other mortgage-related assets. The Company
conducts third party lending and mortgage conduit activities through IndyMac
Operating, which is not a qualified REIT subsidiary of IndyMac REIT and which is
subject to applicable federal and state income taxes. See "Certain Federal
Income Tax Considerations." The Company's other operations include (1)
Construction Lending Corporation of America ("CLCA"), which offers a variety of
construction, land and lot loan programs for builders and developers, (2)
Warehouse Lending Corporation of America ("WLCA"), which provides various types
of short-term revolving financing to small-to-medium size mortgage originators
and offers builder inventory lines of credit, (3) IndyMac Construction Lending
Division ("IndyMac CLD"), which facilitates the purchase of a variety of
construction, land and lot loans through IndyMac Operating's third party lending
customers, (4) IndyMac Manufactured Housing Division ("IndyMac MHD"), which
facilitates the direct origination or purchase of consumer loans and mortgage
loans secured by manufactured housing, (5) IndyMac Home Improvement Division
("IndyMac HID"), which facilitates the direct origination or purchase of home
improvement loans, and (6) LoanWorks, which facilitates the direct origination
of a variety of residential loans.
IndyMac Operating was established in 1993 as a nationwide, third-party lender
and securitizer of residential prime and, to a lesser extent, sub-prime mortgage
loans. IndyMac Operating also performs master servicing for all loans and
mortgage-backed securities owned or issued by it. Prior to 1993,
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/1/ Except for the historical information contained in this Form 10-K, certain
items herein, including without limitation, certain matters discussed under
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" in Part II, Item 7 of this Form 10-K ("MD&A") are forward-looking
statements. The matters referred to in such statements could be affected by the
risks and uncertainties involved in the Company's businesses, including without
limitation, the effect of economic and market conditions, the level and
volatility of interest rates, the actions undertaken by both current and
potential new competitors, the impact of current, pending or future legislation
and regulations and other risks and uncertainties detailed in the MD&A.
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IndyMac REIT was primarily a passive investor in single-family, first-lien,
residential mortgage loans and mortgage backed securities financed by
collateralized mortgage obligations (the "CMO Portfolio").
THIRD PARTY LENDING OPERATIONS
Mortgage Conduit Operations. The Company operates a jumbo and nonconforming
mortgage loan conduit. With respect to its nonconforming mortgage loan conduit
operations, the Company acts as an intermediary between (i) the third party
originators of mortgage loans that do not qualify for purchase by or inclusion
in loan guarantee programs sponsored by the government and government sponsored
entities ("GSEs") (i.e., Government National Mortgage Association ("GNMA"),
Federal National Mortgage Association ("Fannie Mae") and Federal Home Loan
Mortgage Corporation ("Freddie Mac")) ("nonconforming mortgage loans") and (ii)
permanent investors in mortgage-backed securities secured by or representing an
ownership interest in such mortgage loans. All loans purchased by IndyMac REIT
for which a real estate mortgage investment conduit ("REMIC") transaction or
whole loan sale is contemplated are committed for sale to IndyMac Operating at
the same price at which the loans were acquired by IndyMac REIT, pursuant to the
terms of a master forward commitment agreement between IndyMac REIT and IndyMac
Operating, which was originally entered into in 1993. The Company's mortgage
conduit operations consist of the purchase and securitization of mortgage loans
secured by first and second liens on single (one-to-four) family residential
properties that are originated in accordance with the Company's underwriting
guidelines. The Company and its third party lending customers ("sellers")
negotiate whether such sellers will retain, or the Company will purchase, the
rights to service the mortgage loans delivered by such sellers to the Company.
The Company subcontracts the servicing associated with the servicing rights
acquired primarily to CHL and, to a lesser extent, other third party servicers.
The Company's principal sources of income from its mortgage conduit operations
are gains recognized on the sale of mortgage loans and securities, master
servicing revenue, and the net spread between interest earned on mortgage loans
and the interest costs associated with the borrowings used to finance such loans
pending their securitization or sale.
Marketing Strategy. The Company's third party lending operations are designed
to attract both large and small sellers of nonconforming mortgage loans by
offering a variety of products, pricing,loan underwriting and funding methods
designed to be responsive to such sellers' needs, although during 1997 the
Company sought to focus on the smaller seller market where the Company believes
purchase margins may be higher. In this regard, the Company began a more
extensive table funding effort during 1997. Through this method of funding, the
Company provides the funds for the closing of mortgage loans that are arranged
by smaller sellers. Although the Company generally assumes more regulatory and
credit risk with respect to the mortgage loans funded in this manner, the
Company has established controls to ensure the loans comply with regulatory
requirements and meet the Company's credit guidelines.
The Company expects to continue to introduce niche loan products from time to
time, which may give the Company temporary competitive advantages. The
Company's products include fixed-rate and adjustable-rate mortgage loans, loans
to foreign nationals, reduced documentation loans, non-owner occupied loans,
loans secured by alternative types of collateral in addition to residential real
estate, subprime credit quality loans, consumer and mortgage loans secured by
manufactured housing, and home improvement loans. In response to the perceived
needs of nonconforming mortgage loan sellers, the Company's marketing strategy
seeks to offer competitive pricing, response time efficiencies in the purchase
process, direct and frequent contact through a trained sales force and flexible
commitment programs. In addition, through its construction lending division,
the Company offers combined construction-to-permanent mortgage loans,
subdivision construction loans, land acquisition and development loans, lot
loans, model home loans, certain condominium loans, income property construction
and terms loans and builder custom home loans. The Company's warehouse lending
division offers traditional revolving lines of credit to mortgage originators
secured by the financed mortgage loans.
The Company's third party lending sales and marketing staff, as well as certain
of its operations areas, are established to pursue business on a servicing-
released or servicing-retained basis and to market products
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effectively to mortgage bankers and brokers of all sizes. The third party
lending sales force cross-sells products for all of the Company's business
lines.
The Company has two principal underwriting methods designed to be responsive to
the needs of nonconforming mortgage loan sellers. The first method established
by the Company is a delegated underwriting program which is similar in concept
to the delegated underwriting programs established by Fannie Mae, Freddie Mac
and GNMA. Under this program, mortgage loans are underwritten in accordance
with the Company's guidelines by the seller and purchased, in reliance on the
seller's representations and warranties, on the basis of the seller's financial
strength, historical loan quality and other qualifications. Eligibility
requirements for the delegated underwriting program vary based upon the net
worth of a seller. The delegated underwriting program enables sellers to
deliver loans to the Company without time delay imposed by the Company's
underwriters or a third party underwriter. A sample of loans submitted by each
seller pursuant to the delegated underwriting program is subsequently reviewed
by the Company in accordance with its quality control guidelines. See "Quality
Control" herein. Under the Company's second underwriting method, sellers submit
to the Company mortgage loans that are underwritten by the Company in accordance
with its guidelines.
Mortgage Loans Acquired. Substantially all of the mortgage loans purchased
through the Company's mortgage conduit operations are nonconforming mortgage
loans. Nonconforming mortgage loans are loans which do not qualify for purchase
by Freddie Mac or Fannie Mae or for inclusion in a loan guarantee program
sponsored by GNMA. Nonconforming mortgage loans generally consist of jumbo
mortgage loans or loans which are not originated in accordance with other GSE
criteria. Currently, the maximum principal balance for a conforming loan is
$227,150. Loans that exceed such maximum principal balance are referred to as
"jumbo loans." The Company generally purchases jumbo loans with original
principal balances of up to $3 million. The Company's loan purchase activities
focus on those regions of the country where higher volumes of jumbo mortgage
loans are originated, including California, Connecticut, Florida, Hawaii,
Illinois, Maryland, Michigan, New Jersey, New York, Ohio, Texas, Virginia,
Washington and Washington, DC. The Company's highest concentration of mortgage
loans relates to properties in California because of the generally higher
property values and mortgage loan balances prevalent there. Mortgage loans
secured by California properties accounted for approximately 46% of the mortgage
loans purchased by the Company in 1997.
Mortgage loans acquired by the Company are secured by primarily first, and to a
lesser extent, second liens on single (one-to-four) family residential
properties with either fixed or adjustable interest rates. Fixed-rate mortgage
loans accounted for approximately 81% of the mortgage loans purchased by the
Company in 1997 compared to 79% for 1996. The number of adjustable rate
mortgage ("ARM") loans purchased by the Company has decreased from 21% of all
mortgage loans purchased in 1996 to 19% of 1997 mortgage loan purchases.
Seller Eligibility Requirements. The mortgage loans acquired pursuant to the
Company's third party lending operations are originated by various sellers,
including savings and loan associations, banks, mortgage bankers, mortgage
brokers and other mortgage lenders. Sellers are required to meet certain
regulatory, financial, insurance and performance requirements established by the
Company before they are eligible to participate in the Company's mortgage loan
purchase programs and must submit to periodic reviews by the Company to ensure
continued compliance with these requirements. The Company requires that sellers
that perform mortgage loan servicing for the Company and participate in the
Company's delegated underwriting program, have a minimum level of tangible net
worth, be approved as a Fannie Mae or Freddie Mac seller/servicer in good
standing, be approved as a U.S. Department of Housing and Urban Development
("HUD") approved mortgagee in good standing, or be a financial institution that
is insured by the Federal Deposit Insurance Corporation ("FDIC") or comparable
federal or state agency and is supervised and examined by a federal or state
authority. In addition, sellers are required to have comprehensive loan
origination quality control procedures. In connection with its qualification,
each seller enters into an agreement that provides for recourse by the Company
against such seller under various circumstances, including in the event of any
material breach of a representation
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or warranty made by the seller with respect to mortgage loans sold to the
Company, any fraud or misrepresentation during the mortgage loan origination or
acquisition process or upon early payment default on such loans.
Servicing Retention. Certain sellers of mortgage loans to the Company have
contracted with the Company to retain the rights to service the mortgage loans
purchased by the Company. Servicing includes collecting and remitting loan
payments, making required advances, accounting for principal and interest,
holding escrow or impound funds for payment of taxes and insurance, if
applicable, making required inspections of the mortgaged property, contacting
delinquent borrowers and supervising foreclosures and property dispositions, in
the event of unremedied defaults in accordance with the Company's guidelines.
The servicer is required to perform these servicing functions pursuant to
standards set forth in the Company's guidelines. The servicer receives fees
generally ranging from 1/4% to 1/2% per annum on the declining principal
balances of the loans serviced. If a seller/servicer breaches certain of its
representations and warranties made to the Company, the Company may terminate
the servicing rights of such seller/servicer and sell or assign such servicing
rights to another servicer. Under certain circumstances not involving default
by the seller/servicers, seller/servicers have the option to request the Company
to purchase such servicing rights at a price based on a current market
valuation. The Company subcontracts the servicing associated with the servicing
rights it acquires primarily to CHL and, to a lesser extent, other third party
servicers.
Master Servicing. The Company acts as master servicer with respect to
substantially all of the mortgage loans it sells pursuant to securitizations.
Master servicing includes collecting loan payments from seller/servicers of
loans and remitting loan payments, less master servicing fees and other fees,
to trustees. In addition, as master servicer, the Company monitors the
servicer's compliance with the Company's servicing guidelines and is required to
perform, or to contract with a third party to perform, all obligations not
adequately performed by any servicer. The master servicer may permit or require
the servicer to contract with approved subservicers to perform some or all of
the servicer's servicing duties, but the servicer is not thereby released from
its servicing obligations.
In connection with REMIC issuances and whole loan sales, the Company master
services on a non-recourse basis substantially all of the mortgage loans it
sells. Each series of mortgage-backed securities is typically fully payable
from the mortgage assets underlying such series and the recourse of investors is
generally limited to those assets and any credit enhancement features, such as
insurance. As a general rule, any losses in excess of the accompanying credit
enhancement obtained is borne by the security holders. Except in the case of a
breach of the standard representations and warranties made by the Company when
mortgage loans are securitized or sold, the securities or sales are non-recourse
to the Company. In most cases, the Company has recourse to the sellers of loans
for any such breaches, although there can be no assurance that the seller will
be able to honor its obligations.
Master Commitments. As part of its marketing strategy, the Company establishes
mortgage loan purchase commitments ("Master Commitments") with sellers that,
subject to certain conditions, entitle the seller to sell and the Company to
purchase a specified dollar amount of nonconforming mortgage loans over a period
generally ranging from three months to one year. The terms of each Master
Commitment specify whether a seller may sell loans to the Company on a mandatory
or best efforts basis, or a combination thereof. Master Commitments do not
obligate the Company to purchase loans at a specific price but rather provide
the seller with a future outlet for the sale of its originated loans based on
the Company's quoted prices at the time of rate lock, reduced by, with respect
to certain loan products, a negotiated price break. Master Commitments specify
the types of mortgage loans the seller is entitled to sell to the Company and
generally range from $5 million to $500 million in aggregate committed principal
amount. The Master Commitment also specifies whether the seller will retain or
release to the Company the right to service delivered mortgage loans.
Bulk and Other Rate-Locks. The Company also acquires mortgage loans from
sellers that are not purchased pursuant to Master Commitments. These purchases
may be made on a bulk or individual rate-lock basis. Bulk rate-locks obligate
the seller to sell and the Company to purchase a specific group of
4
loans, generally ranging from $1 million to $50 million in aggregate committed
principal amount, at set prices on specific dates. Bulk rate-locks enable the
Company to acquire substantial quantities of loans on a more immediate basis.
The specific pricing, delivery and program requirements of these purchases are
determined by negotiation between the parties but are generally in accordance
with the provisions of the Company's Seller Guide. Due to the active
presence of investment banks and other substantial investors in this area,
purchasing loans under bulk pricing is extremely competitive. Loans are also
purchased from individual sellers (typically smaller originators of mortgage
loans) that do not wish to sell loans pursuant to either a Master Commitment or
bulk rate-lock. The terms of these individual purchases are based primarily on
the Company's Seller Guide and standard pricing provisions, and are offered on a
mandatory or best efforts basis.
Following the issuance of specific rate-locks related to loans held for sale,
IndyMac Operating is subject to the risk of interest rate fluctuations with
respect to the contractual rate of interest on such loans, and will enter into
hedging transactions to diminish such risk. Hedging transactions may include
mandatory or optional forward sales of mortgage loans or mortgage-backed
securities, mandatory forward sales or financings using REMICs, mandatory or
optional sales of futures and other financial futures transactions. See
"Securitization Process". The nature and quantity of hedging transactions will
be determined by management based on various factors, including market
conditions, the expected or contracted volume of mortgage loan purchases and the
product types or coupon rates to be purchased. In addition, the Company will not
engage in any financial futures transaction unless the Company would be exempt
from the registration requirements of the Commodity Exchange Act or otherwise
complies with the provisions thereof.
Purchase/Underwriting Guidelines. The Company has developed comprehensive
purchase guidelines for its acquisition of loans. Subject to certain
exceptions, each loan purchased must conform to the Company's loan eligibility
requirements specified in the Company's Seller Guide with respect to, among
other things, loan amount, type of property, loan-to-value ratio, type and
amount of insurance, credit history of the borrower, income ratios, sources of
funds, appraisal and loan documentation. The Company also performs a legal
documentation review prior to the purchase of any loan and where the seller is
not authorized to participate in one of the Company's delegated programs, the
Company performs a full credit review and analysis to ensure compliance with its
loan eligibility requirements. Generally, the latter review includes, among
other things, an analysis of the underlying property and associated appraisal
and an examination of the credit, employment and income history of the borrower.
For loans purchased pursuant to the Company's delegated underwriting program,
the Company relies on the credit review performed by the seller and the
Company's own follow-up quality control procedures. See discussion of the
Company's underwriting methods under "Marketing Strategy" herein.
Quality Control. Ongoing quality control reviews are conducted by the Company to
ensure that the loans purchased meet the Company's quality standards. The type
and extent of the quality control review depends on the nature of the seller and
the characteristics of the loans. The Company conducts a full post-purchase
underwriting review of all of the loans purchased during the first month of a
seller's participation in the delegated underwriting program to monitor ongoing
compliance with the Company's guidelines. The percentage of loans fully reviewed
is reduced to approximately 50% during the second month, and thereafter reduced
monthly in 10% increments to approximately 10% after six months, and maintained
at this level throughout the seller's participation in the delegated
underwriting program. A higher percentage of mortgage loans with certain
specified characteristics are reviewed by the Company following purchase,
including loans in excess of $650,000 in principal amount, loans originated by
sellers with a 60 day delinquency percentage (percentage of all loans sold by a
seller to the Company that are delinquent for 60 or more days) that is 1.25% of
the average 60 day delinquency percentage for all loans purchased by the Company
and all loans that are delinquent for 60 or more days. In performing a quality
control review on a loan, the Company analyzes the underlying property and
associated appraisal and examines the credit, employment and income history of
the borrower. In addition, all documents submitted in connection with the loan,
including all insurance policies, appraisals and credit records, and the closing
statement, sales contract and escrow instructions are examined for compliance
with the Company's underwriting guidelines. Furthermore, the Company reverifies
the employment, income and source of funds documentation, as appropriate, of
each borrower and obtains a
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new credit report and independent appraisal, with respect to approximately 10%
of the reviewed loan sample.
SECURITIZATION PROCESS
General. The Company primarily uses repurchase agreements, bank borrowings,
unsecured debt and equity to finance the initial acquisition of mortgage loans
from sellers. When a sufficient volume of fixed rate loans with similar
characteristics has been accumulated, generally $100 million to $500 million in
principal amount, such loans are securitized through the issuance of mortgage-
backed securities in the form of REMICs or CMOs or resold in bulk whole loan
sales. The length of time between when the Company commits to purchase a
mortgage loan and when it sells or securitizes such mortgage loan generally
ranges from ten to 90 days, depending on certain factors, including the length
of the purchase commitment period, the loan volume by product type, market
fluctuations in the prices of mortgage-backed securities and variations in the
securitization process. With respect to subprime, manufactured housing and home
improvement loans, this holding period generally will be longer, due to an
overall smaller market combined with the shorter period of time the Company has
been operating these programs.
The Company is subject to various risks due to potential interest rate
fluctuations during the period of time after the Company commits to purchase a
mortgage loan at a pre-determined price until such mortgage loan is ultimately
sold. The Company has attempted to mitigate such risks through the
implementation of hedging policies and procedures. In accordance with its
hedging policies and procedures, the Company seeks to utilize financial
instruments whose price sensitivity has very close inverse correlation to the
price sensitivity of the related mortgage loans as a result of changes in
applicable interest rates. With respect to the Company's portfolio of jumbo and
nonconforming fixed-rate loans, the financial instrument which has historically
demonstrated close inverse correlation, and also trades in a relatively liquid
and efficient manner, is a forward commitment to sell a Fannie Mae or Freddie
Mac security of comparable maturity and weighted average interest rate.
However, the Company's private-label mortgage securities typically trade at a
discount (or "spread") compared to the corresponding Fannie Mae or Freddie Mac
securities, due to the implied government guarantees of certain Fannie Mae or
Freddie Mac obligations. Accordingly, while the Company's hedging strategy may
mitigate the impact that changes in interest rates would have on the price of
agency mortgage securities (and therefore to some extent on the price of the
Company's private-label mortgage securities), such strategy does not protect the
Company against the effects of a widening or narrowing in the pricing spread
between agency mortgage securities and the Company's private-label mortgage
securities. Therefore, any significant widening or narrowing of the spread
commanded by agency mortgage securities compared to the Company's private-label
mortgage securities could have a positive or negative effect on the financial
performance of the Company, regardless of the efficiency of the Company's
execution of its hedging strategy.
With respect to the Company's portfolio of subprime, manufactured housing and
home improvement loans, the Company generally utilizes forward sales of Treasury
futures to hedge against the effects of interest rate fluctuations. Although
Treasury futures may protect the Company's subprime, manufactured housing and
home improvement loan portfolios against fluctuations of short-term interest
rates, such hedging activities may not always result in precise inverse
correlation to changes in the values of the underlying loans. The lack of exact
inverse correlation is due to such factors as changes in the relative pricing
discount between mortgage or asset backed securities and Treasury securities,
and perceived credit risks in the whole loan market. To the extent any changes
in the value of the instruments used to hedge the risk of interest rate
fluctuations do not inversely correlate precisely to the risks affecting the
value of the Company's subprime, manufactured housing and home improvement loan
portfolios, the financial performance of the Company could be negatively or
positively impacted.
The Company's decision to form REMICs or CMOs or to sell whole loans in bulk is
influenced by a variety of factors. REMIC transactions are generally accounted
for as sales of the mortgage loans and may eliminate or minimize any long-term
residual investment by the Company in such loans, depending on the
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extent to which the Company decides to retain residual or other interests. REMIC
securities typically consist of one or more classes of "regular interests" and a
single class of "residual interest." The regular interests are tailored to the
needs of investors and may be issued in multiple classes with varying
maturities, average lives and interest rates. These regular interests are
predominantly senior securities but, in conjunction with providing credit
enhancement, may be subordinated to the rights of other regular interests. The
residual interest represents the remainder of the cash flows from the loans
(including, in some instances, reinvestment income) over the amounts required to
be distributed to the regular interests. In some cases, the regular interests
may be structured so that there is no significant residual cash flow, thereby
allowing the Company to sell its entire interest in the loans. As a result, in
some cases the capital originally invested in the loans by the Company may be
redeployed in the third party lending operations. The Company may also retain
regular and residual interests on a short-term or long-term basis. The creation
of REMIC securities through IndyMac Operating is the Company's preferred method
of securitizing loans, because this method provides the maximum flexibility in
structuring securities for sale to the broadest group of investors and may
permit the redeployment of a portion of the capital of the Company. Beginning in
the third quarter of 1993, the Company began issuing all of its REMIC securities
utilizing a shelf registration statement established by CWMBS, Inc., a wholly
owned limited purpose finance subsidiary of CCR. Neither CWMBS, Inc. nor CCR
derives any financial benefit from such issuances, other than recoupment of a
portion of the allocable costs of establishing and maintaining the shelf
registration.
As an alternative to REMIC sales, the Company may issue CMOs to finance mortgage
loans to maturity. For accounting and tax purposes, the mortgage loans financed
through the issuance of CMOs are treated as assets of the Company, and the CMOs
are treated as debt of the Company. The Company earns the net interest spread
between the interest income on the mortgage loans and the interest and other
expenses associated with the CMO financing. The net interest spread will be
directly impacted by the levels of prepayment of the underlying mortgage loans
and, to the extent CMO classes have variable rates of interest, may be affected
by changes in short-term interest rates. The Company is required to retain a
residual interest in its issued CMOs. The Company may issue CMOs from time to
time based on the Company's current and future investment needs, market
conditions and other factors. CMOs, however, do not offer the Company the
structuring flexibility of REMICs and are expected to be a secondary method of
securitizing the Company's mortgage loans.
From time to time, the Company also may sell whole loans in bulk as an
alternative to REMIC sales or the issuance of CMOs. Such sales result in the
removal of the assets from the Company's balance sheet and immediate recognition
of a gain or loss.
Credit Enhancement. REMICs or CMOs created by the Company are structured so
that, in general, substantially all of such securities are rated investment
grade by at least one nationally recognized statistical rating agency. In
contrast to mortgage-backed securities in which the principal and interest
payments are guaranteed by the U.S. government or an agency thereof, securities
created by the Company do not benefit from any such guarantee. The ratings for
the Company's mortgage-backed securities are based on the perceived credit risk
by the applicable rating agency of the underlying mortgage loans, the structure
of the securities and the associated level of credit enhancement. Credit
enhancement is designed to provide protection to one or more classes of security
holders in the event of borrower defaults and to protect against other losses,
including those associated with fraud or reductions in the principal balances or
interest rates on loans as required by law or a bankruptcy court. The Company
can utilize multiple forms of credit enhancement, including bond insurance
guarantees, mortgage pool insurance, special hazard insurance, reserve funds,
letters of credit, surety bonds and subordination of certain classes of
interests to other classes, or any combination thereof.
In determining whether to provide credit enhancement through bond insurance,
subordination or other credit enhancement methods, the Company will take into
consideration the costs associated with each method. The Company principally
provides credit enhancement through the issuance of mortgage-backed
7
securities in senior/subordinated structures. The subordinated securities may be
sold, retained by the Company and accumulated for sale in subsequent
transactions, or retained as long term investments.
Retention of Mortgage-Backed Securities and Other Investments. In connection
with the issuance of mortgage-backed securities or other investments in the form
of REMICs or CMOs, the Company may retain subordinated securities or regular or
residual interests (including residual interests that may be subordinated to
other classes of securities) on a short-term or long-term basis. Any such
retained residual or regular interest may include "principal-only" or "interest-
only" securities, mortgage servicing rights, or other interest rate- or
prepayment-sensitive securities or investments. The Company has assumed a
certain degree of credit risk in relation to its portfolio of subordinated
securities. See "Credit Risk" below.
Mortgage servicing rights have characteristics similar to interest-only
securities; accordingly, they have many of the same risks inherent in interest-
only securities, including the risk that they will lose a substantial portion of
their value as a result of rapid prepayments occasioned by declining interest
rates. It is also possible that under certain high prepayment scenarios, the
Company would not recoup its initial investment in mortgage servicing rights or
interest-only securities. Investments in mortgage servicing rights and interest-
only securities have values which tend to move inversely to the values of the
retained subordinated and principal-only securities as interest rates change.
For example, as interest rates decline, prepayments would tend to increase and
the value of the Company's mortgage servicing rights and interest-only
securities would tend to decrease. By contrast, in a declining interest rate
environment, the value of the Company's portfolio of subordinated securities and
principal-only securities would tend to increase because the rise in prepayments
would tend to accelerate return of the Company's investment in the principal
portion of the underlying loans. The Company seeks to manage the effects of
rising and falling interest rates through investing in financial instruments
with contrasting sensitivities to interest rates; however, there can be no
assurance that this strategy will succeed under any particular interest rate
scenario. In addition, the Company has used U.S. Treasury bonds, call options on
U.S. Treasury bonds and interest rates floors that react inversely to changes in
interest rates compared to the Company's mortgage servicing rights and interest-
only securities in an effort to further reduce the interest rate risk associated
with such mortgage servicing rights and interest-only securities.
In addition to its retention of subordinated securities or regular or residual
interests, the Company has also invested in AAA-rated securities for the purpose
of growing its investment portfolio and net interest income.
LOANS HELD FOR INVESTMENT
In an effort to generate continuing earnings that are less dependent upon the
Company's loan purchase volumes and securitization activities, the Company seeks
to selectively invest in residential loans on a long-term basis. The Company
finances the acquisition of such loans with its capital, borrowings under
repurchase agreements and other credit facilities referred to under "Financing
Sources" below. The Company has assumed a certain degree of credit risk in
relation to its portfolio of loans held for investment. See "Credit Risk"
below.
CONSTRUCTION LENDING
The Company's construction lending group consists of two operating divisions:
CLCA, which offers a variety of income property construction and term loan
programs, and residential construction, land and lot loan programs for builders
and developers, and IndyMac CLD, which offers a variety of residential
construction, land and lot loan programs through IndyMac Operating's third party
customers.
The baseline project for CLCA's residential construction loan program is a 15 to
100 unit subdivision, built in one to five phases, that will be marketed to
entry level/first-time or trade-up buyers. In general, the maximum loan size
per project is $15 million. The specific terms of any construction loan,
including the principal amount thereof and the applicable interest rate and
fees, are based upon, among other things, the location of the project, the value
of the land and the financial strength, historical performance and other
qualifications of the builder. All builder construction loans with principal
balances in excess of $1,000,000 are subject to the prior approval of a credit
committee comprised of senior officers of IndyMac REIT.
8
Combined construction-to-permanent loans, home improvement loans and lot loans
are originated by IndyMac Operating's third party customers. IndyMac CLD
assists IndyMac REIT in the purchase of such loans and administers the
construction draws. Under these programs, all loans are prior-approved and
underwritten to the Company's standard guidelines for borrower qualifications,
as well as other detailed criteria. Criteria for the permanent loans are
similar to those applied by IndyMac Operating to loans purchased generally. In
general, the maximum construction-to-permanent loan size is $3 million. The
Company has assumed a certain degree of credit risk in relation to its
construction lending activities. See "Credit Risk" below.
WAREHOUSE LENDING
WLCA engages in secured warehouse lending operations for small- and medium-size
mortgage originators. WLCA also offers builder inventory lines of credit. The
Company's traditional warehouse lending facilities typically provide short-term
revolving financing to mortgage companies to finance the origination of mortgage
loans during the time between the closing of such loans and their sale to
investors. Loans financed by WLCA through its traditional warehouse lending
activities represent a broader line of mortgage products than those currently
purchased by the Company. Presently all of such loan products purchased by the
Company are eligible for financing by WLCA under the financing agreements used
by WLCA to fund its operations.
Under its standard program, WLCA offers credit facilities to otherwise qualified
mortgage originators with a minimum audited tangible net worth of $100,000 and
subject to a maximum debt-to-net-worth ratio of 22 to 1. Under its Advantage
Line and Captive Line programs, WLCA offers credit facilities to otherwise
qualified mortgage originators with no net worth requirement. Under its builder
inventory program, WLCA offers lines of credit to home builders to temporarily
finance inventories of residential homes. Under this program, builders generally
must have a minimum tangible net worth of $5 million, with a maximum leverage
ratio (total liabilities to tangible net worth) of 6 to 1. The specific terms of
any warehouse line of credit, including the maximum credit limit, are determined
based upon the financial strength, historical performance and other
qualifications of the mortgage originator. All lines of credit under the
standard program and the builder inventory program are subject to the prior
approval of a credit committee comprised of senior officers of IndyMac REIT. The
Company finances these WLCA programs through a combination of repurchase
agreements, equity and other borrowings. With respect to WLCA's operations, the
Company has three committed two-year repurchase agreement facilities with three
investment banks with sublimits in an aggregate amount of up to $500 million,
and one committed three-year credit facility with a syndicate of nine commercial
banks with sublimits in an aggregate amount of up to $225 million.
MANUFACTURED HOUSING
IndyMac MHD was established in December 1995 and facilitates the origination,
purchase, sale and servicing of loans to consumers who are purchasing or
refinancing a new or used manufactured home. This division solicits business
through established dealer networks, brokers, "in-park" marketing activities and
the Company's third party lending sales and marketing staff. The Manufactured
Housing Division operates five regional offices in San Diego, CA, Houston, TX,
Atlanta, GA, Vancouver, WA and Raleigh, NC.
HOME IMPROVEMENT DIVISION
IndyMac HID began operations in May 1997 and facilitates the origination,
purchase, sale and servicing of consumer home improvement and debt consolidation
loans secured by liens on improved real property. IndyMac HID's primary sales,
origination and servicing facility is located in Atlanta, GA. IndyMac HID also
operates six regional sales offices in Tampa, FL, Winston-Salem, NC, Newark, NJ,
Memphis, TN, Pittsburgh, PA and Kansas City, MO. IndyMac HID provides financing
through two primary distribution channels: home improvement dealers and
specialty brokers. IndyMac HID also facilitates the purchase of consumer home
improvement and debt consolidation loans through IndyMac Operating's third party
customers.
9
LOANWORKS
LoanWorks, which offers a variety of residential mortgage loans directly to
consumers, including conforming conventional mortgage loans, and prime and sub-
prime, non-conforming mortgage loans, began operations in January 1997.
LoanWorks' operations are centralized in a telemarketing and processing center
located in Irvine, CA and LoanWorks' primary marketing tools are media
advertising in Southern California and internet advertising through its web site
at "http://www.loanworks.com". Through its telemarketing operations, LoanWorks
loan consultants counsel consumers with respect to the loan application process,
process loan applications and render lending decisions, providing for a
streamlined loan application process.
CREDIT RISK
The Company has assumed a certain degree of credit risk in connection with its
investments in mortgage securities and loans held for investment, as well as in
connection with its third party lending, construction lending and warehouse
lending operations. The Company evaluates and monitors its exposure to credit
losses and has established a reserve for anticipated credit losses based upon
estimated future losses on the loans, general economic conditions and trends in
portfolio volume. The Company likewise has assumed a certain degree of credit
risk in connection with its investment in subordinated securities. Such
securities are recorded net of a discount which represents the estimated credit
losses associated with such securities.
The Company has experienced a decrease in delinquencies associated with its held
for investment residential loans. Delinquencies on this portfolio declined to
6.3% from 8.7% for the periods ending December 31, 1997 and 1996, respectively.
Similarly, the Company has experienced a decrease in delinquencies associated
with its held for sale residential loans. Delinquencies on this portfolio
declined to 2.3% from 5.0% for the periods ending December 31, 1997 and 1996,
respectively.
As of December 31, 1997, the Company had accumulated $27.4 million in loan loss
reserves associated with the loans owned by both IndyMac REIT and IndyMac
Operating, and net charge-offs from inception to date totaled $10.8 million. In
addition, the Company suspends the accrual of income on loans 90 days or greater
past due where full collectibility is in doubt.
The Company has invested in interest-only securities, principal-only securities,
inverse floater securities and other mortgage-backed securities, which include
investment grade securities (i.e., rated BBB or higher) and non-investment grade
or subordinated securities (i.e., rated lower than BBB). As of December 31, 1997
investment grade securities comprised 58% of the Company's mortgage-backed
securities portfolio. In general, subordinated securities bear all losses prior
to the related senior securities and, therefore, the Company has credit risk
with respect to the subordinated securities in its mortgage-backed securities
portfolio. However, the Company's subordinated securities portfolio was acquired
at a discount of $61 million to such securities' face value. This discount
primarily reflects estimates of future expected credit losses on approximately
$3.8 billion of single-family mortgage loans which are related to the
subordinated securities.
With respect to its construction loan portfolio, warehouse lending operations
and manufactured housing lending operations, the Company has sought to institute
significant operational controls in order to help minimize credit risk. Charge-
offs with respect to the Company's construction loans for the year ended
December 31, 1997 were $71,000. Since the Company's current actual experience is
not necessarily indicative of future losses, as of December 31, 1997, $7.2
million in loan loss reserves had been allocated to construction lending
activities. The warehouse lending program commenced in May 1993. Since that time
there has been one loan charge-off amounting to approximately $45,000 that was
not subsequently recovered. Since the Company's current actual experience is not
necessarily indicative of future losses, as of December 31, 1997, $1.8 million
in loan loss reserves had been allocated to warehouse lending activities. For
the year ended December 31, 1997, charge-offs with respect to the Company's
manufactured housing lending division, which began operations in December 1995,
were $220,000. As of December 31, 1997, $74,000 in loan loss reserves had been
allocated to manufactured housing lending operations.
In addition to the creation of reserves, the Company has established a risk
management committee to further manage the Company's exposure to credit losses.
This committee reviews the products the Company offers, the authority limits of
the Company's customers and personnel and customers' performance, and implements
changes that seek to balance the Company's credit risk with the Company's
production and profitability goals. Additionally, the Company deploys a risk-
based pricing approach in an effort to price products based in part on the
credit risks associated with each product. While management cannot offer any
assurance as to the extent to which the Company will incur credit losses
10
and any related effects on earnings, controls are in place in an effort to
reduce exposure in this area.
FINANCING SOURCES
The Company uses proceeds from the sale of REMIC securities and CMOs, repurchase
agreements, other borrowings and issuance of common stock and unsecured debt to
meet its working capital needs. For further information on the material terms
of the borrowings utilized by the Company to finance its inventory of mortgage
loans and mortgage-backed securities, see "Management's Discussion and Analysis
of Financial Condition and Results of Operations--Liquidity and Capital
Resources." The Company continues to investigate and pursue alternative and
supplementary methods to finance its operations through the public and private
capital and credit markets.
FEDERAL INCOME TAX CONSIDERATIONS
IndyMac REIT has elected to be taxed as a REIT under the Internal Revenue Code
and intends to continue to do so. IndyMac Operating is not a qualified REIT
subsidiary and is not consolidated with IndyMac REIT for either tax or financial
reporting purposes. Consequently, IndyMac Operating's earnings are subject to
applicable federal and state income taxes. IndyMac REIT will include in taxable
income amounts earned by IndyMac Operating only when IndyMac Operating remits
its after-tax earnings by dividend to IndyMac REIT.
On February 2, 1998, President Clinton announced his Fiscal Year 1999 Budget
Proposal ("the Budget Proposal"). One of the tax measures included in the Budget
Proposal would curtail a REIT's ability to utilize taxable subsidiaries. Under
this proposal, a REIT such as IndyMax REIT would be prohibited from owning
securities representing more than 10% of the vote or value of another
corporation (unless the other corporation is a wholly-owned qualified REIT
subsidiary). Although IndyMac REIT does not own any of the voting stock of
IndyMac Operating (IndyMac REIT owns 100% of the preferred stock of IndyMac
Operating), IndyMac REIT holds (through its preferred stock ownership) 99% of
the economic interest (or value) in IndyMac Operating. The proposal contains a
grandfather rule for taxable subsidiaries that are in existence on the date of
the first Congressional Committee action on the proposal, which would apply to
IndyMac Operating. However, the grandfathered status would be lost if a taxable
subsidiary acquired substantial new assets after a date to be specified.
If the taxable subsidiary proposal were enacted as proposed, IndyMac Operating
would be grandfathered. However, at this point it is unclear whether IndyMac
Operating would lose such grandfathered status if, in the ordinary course of
business, it acquired substantial new mortgage assets for securitization
purposes. If IndyMac Operating could not acquire new assets, and/or IndyMac
REIT's economic interest in IndyMac Operating were required to be reduced to no
more than 10%, IndyMac REIT would not receive the economic benefits it currently
receives from its ownership interest in IndyMac Operating. In this event,
IndyMac REIT could conduct directly only those activities of IndyMac Operating
that are compatible with IndyMac REIT's status as a REIT (i.e., activities other
than loan sales and REMIC securitizations). Additionally, IndyMac REIT's ability
to service mortgage loans and to hedge mortgage loans held for disposition would
be subject to relatively strict limitations. At this point, no bill has been
introduced containing language that would implement the Budget Proposal, and no
reasonable predictions can be made as to whether such a bill will be introduced
or enacted.
IndyMac REIT's election to be treated as a REIT will be terminated automatically
if IndyMac REIT fails to meet the requirements of the REIT provisions of the
Code. Qualification as a REIT requires that IndyMac REIT satisfy a variety of
tests relating to its income, assets, distribution, administration and
ownership. Although IndyMac REIT believes it has operated and intends to
continue to operate in such a manner as to qualify as a REIT, no assurance can
be given that IndyMac REIT will in fact continue to so qualify. If IndyMac REIT
fails to qualify as a REIT in any taxable year, it would be subject to federal
corporate income tax (including any alternative minimum tax) on its taxable
income at regular corporate rates, and distributions to its shareholders would
not be deductible by IndyMac REIT. In that event, IndyMac REIT would not be
eligible again to elect REIT status until the fifth taxable year which begins
after the year for which IndyMac REIT's election was terminated unless certain
relief provisions apply. IndyMac REIT may also voluntarily revoke its election,
although it has no present intention of doing so, in which event
11
IndyMac REIT would be prohibited, without exception, from electing REIT status
for the year to which the revocation relates and the following four taxable
years.
Distributions to shareholders of IndyMac REIT with respect to any year in which
IndyMac REIT fails to qualify would not be deductible by IndyMac REIT nor would
they be required to be made to such shareholders. In such event, to the extent
of current and accumulated earnings and profits, any distributions to
shareholders would be taxable as ordinary income and, subject to certain
limitations in the Code, eligible for the dividends-received deduction for
corporations. Failure to qualify as a REIT would reduce the amount of IndyMac
REIT's after-tax earnings available for distribution to shareholders and could
result in IndyMac REIT's incurring substantial indebtedness (to the extent
borrowings are feasible), or disposing of substantial investments, in order to
pay the resulting taxes or, at the discretion of IndyMac REIT, to maintain the
level of IndyMac REIT's distributions to its shareholders.
Excess Inclusion Income. A portion of IndyMac REIT's assets may be in the form
of CMO residual interests. Part or all of the income derived by IndyMac REIT
from a residual interest of a CMO issued or invested in by IndyMac REIT after
December 31, 1991, may be "excess inclusion" income, as defined in the Code.
Such excess inclusion income generally is subject to federal income tax in all
events. If IndyMac REIT pays any dividends to its shareholders that are
attributable to excess inclusion income, the shareholders who receive such
dividends generally will be subject to the same tax consequences that would
apply if they derived excess inclusion income from a direct investment in a
REMIC residual interest. Excess inclusion income allocable to a shareholder may
not be offset by current deductions or net operating losses otherwise allowable
as deductions to such shareholder. Moreover, such excess inclusion income
constitutes unrelated business taxable income for tax-exempt entities (including
employee benefit plans). In addition, IndyMac REIT would be subject to tax on
the portion of excess inclusion income that would be allocable to a
"disqualified organization" holding IndyMac REIT shares. IndyMac REIT's bylaws
provide that disqualified organizations are ineligible to hold IndyMac REIT
shares. Approximately 4% of the 1997 dividends paid by IndyMac REIT were
attributable to excess inclusion income.
RELATIONSHIPS WITH COUNTRYWIDE ENTITIES
IndyMac REIT and CCR are each publicly-traded companies whose shares of common
stock are listed on the New York Stock Exchange. CCR directly or indirectly owns
approximately 6.8% of the common stock of IndyMac REIT. CHL, a wholly owned
subsidiary of CCR, owns all of the outstanding voting common stock and 1% of the
economic interest of IndyMac Operating. In addition, several directors and
officers of IndyMac REIT and IndyMac Operating also serve as directors and/or
officers of CCR and/or CHL. See "Part III, Item 13, Certain Relationships and
Related Transactions." IndyMac REIT owns all of the outstanding non-voting
preferred stock and a 99% economic interest in IndyMac Operating. Prior to July
1, 1997, Countrywide Asset Management Corporation, a wholly owned subsidiary of
CCR ("CAMC"), managed IndyMac REIT. See "Historical Operations" below.
HISTORICAL OPERATIONS
Prior to 1993, the Company was principally a long-term investor in single-
family, first-lien, residential mortgage loans and in mortgage-backed securities
representing interests in such loans. The Company's mortgage investment
portfolio consisted primarily of fixed-rate mortgage pass-through certificates
issued by Freddie Mac or Fannie Mae and nonconforming mortgage loans. The
principal source of earnings for the Company historically was interest income
generated from investments in such mortgage loans and mortgage-backed
securities, net of the interest expense on the CMOs or repurchase agreements
used to finance such mortgage investments.
During 1993 and continuing in the beginning of 1994, the CMO Portfolio
experienced substantial prepayments, resulting in significantly decreased net
earnings, and as mortgage loan premiums, original
12
issue discount and bond issuance costs were required to be amortized, losses on
the CMO Portfolio were realized. Regardless of the level of interest rates or
prepayments, IndyMac REIT anticipates no significant earnings from this CMO
Portfolio, and IndyMac REIT could incur additional losses. Any continued
negative performance of this CMO Portfolio will continue to adversely impact the
earnings of IndyMac REIT to the extent of its investment in such portfolio.
On July 1, 1997, IndyMac REIT and CCR completed a transaction whereby IndyMac
REIT acquired all of the outstanding stock of its manager, CAMC, from CCR in
exchange for 3,440,860 new shares of common stock of IndyMac REIT. The
transaction was approved in January 1997 by a special committee consisting of
the independent directors of IndyMac REIT, by the full Board of Directors of
IndyMac REIT, and by the full Board of Directors of CCR. The transaction was
then approved by the IndyMac REIT shareholders at their Annual Meeting held on
June 24, 1997. Following consummation of the transaction, CAMC was merged into
IndyMac REIT ("Merger"), and IndyMac REIT became self-managed. See "Part III,
Item 13, Certain Relationships and Related Transactions."
COMPETITION
In its mortgage conduit operations, the Company competes with established
mortgage conduit programs, investment banking firms, banks, savings and loan
associations, GSEs, mortgage bankers and other lenders and entities purchasing
mortgage assets. Mortgage-backed securities issued through the Company's
mortgage conduit operations face competition from other investment opportunities
available to prospective investors.
The GSEs have made and will continue to make significant technological and
economic advances to broaden their customer bases. There has been much debate
and discussion in Congress and in the news media as to the proper role of these
agencies. If the GSEs contract or expand, there may be a positive or negative
impact on the Company's conduit operations. The Company seeks to address these
competitive pressures by making a strong effort to maximize its use of
technology, by diversifying into other lines of business that are less impacted
by GSEs and by operating in a more cost-effective manner compared to its
competitors, but there can be no assurance that these efforts will succeed.
Effective January 1, 1998, Fannie Mae and Freddie Mac are not permitted to
purchase mortgage loans with original principal balances above $227,150. If
this dollar limitation increases, Fannie Mae and Freddie Mac may be able to
purchase a greater percentage of the loans in the secondary market than they
currently acquire, and the Company's ability to maintain or increase its current
loan acquisition levels could be adversely affected.
WLCA, CLCA and IndyMac CLD face competition from banks and other financial
institutions. Many of these institutions have significantly greater financial
resources and a lower cost of funds than the Company. The Company seeks to
compete with these institutions through an emphasis on quality of service and
diversified products.
IndyMac MHD's primary competition is from banks and other financial
institutions, independent finance companies and captive manufactured housing
finance companies. IndyMac HID's primary competition is from diversified
mortgage banking companies, banks and other financial institutions, credit card
companies, financial services affiliates of dealers and independent financial
services companies. LoanWorks' primary competition is from banks and other
financial institutions and mortgage companies. The Company seeks to compete with
these various finance and mortgage companies and financial institutions through
an emphasis on quality of service, diversified products and maximum use of
technology.
EMPLOYEES
Beginning on July 1, 1997 in connection with the Merger, the former employees of
CAMC that conducted the operations of the Company became employees of either
IndyMac REIT or IndyMac Operating. As of December 31, 1997, IndyMac REIT had
171 employees and IndyMac Operating had 621 employees.
13
ITEM 2. PROPERTIES
- ------- ----------
The primary executive and administrative offices of the Company and its
subsidiaries are located at 155 North Lake Avenue, Pasadena, California, and
consist of approximately 140,000 square feet. The principal lease relating to
such space expires in 2010. IndyMac Operating also maintains 7,500 square feet
of office space in Mount Laurel, NJ, and the primary lease associated with this
space expires in 2002. IndyMac MHD occupies space located in San Diego, CA, as
well as Atlanta, GA, Raleigh, NC, Vancouver, WA and Houston, TX. These locations
consist of approximately 36,000 square feet, and the principal lease associated
with these properties expires in 2001. IndyMac HID occupies space in Atlanta,
GA, consisting of approximately 10,340 square feet. The principal lease relating
to such space expires in 1999. LoanWorks occupies space in Irvine, CA,
consisting of approximately 6,000 square feet. The principal lease relating to
such space expires in 2002.
ITEM 3. LEGAL PROCEEDINGS
- ------- -----------------
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- ------- ---------------------------------------------------
None.
PART II
ITEM 5. MARKET FOR INDYMAC REIT'S STOCK AND RELATED SECURITY HOLDER MATTERS
- ------- -------------------------------------------------------------------
INMC Mortgage Holdings, Inc.'s common stock is traded on the New York
Stock Exchange ("NYSE") under the symbol "NDE."
The following table sets forth the high and low sales prices (as reported by the
NYSE) for common stock for the years ended December 31, 1997 and 1996 and cash
dividends declared for earnings of the period as indicated.
1997 1996 Dividends Declared
------------------------------------------------------------------------------------------------------
High ($) Low ($) High ($) Low ($) 1997 1996
------------------------------------------------------------------------------------------------------
First Quarter 23 1/4 19 3/8 17 1/2 15 0.42 0.36
Second Quarter 23 15/16 19 1/2 17 7/8 15 0.43 0.37
Third Quarter 25 7/16 22 5/8 20 1/4 16 3/8 0.46 0.39
Fourth Quarter 25 13/16 21 5/8 21 7/8 19 1/2 0.48 0.40
- --------------------------------------------------------------------------------------------------------------------------
As of March 23, 1998, 65,082,991 shares of INMC Mortgage Holdings, Inc.'s common
stock were held by 3,216 shareholders of record.
Pursuant to IndyMac REIT's Dividend Reinvestment and Stock Purchase Plan
("Plan"), shareholders can reinvest their cash dividends in additional shares of
IndyMac REIT's common stock at 99 percent (subject to change) of the average
high and low market prices on the investment date, as defined in the Plan.
Shareholders may also purchase additional shares of IndyMac REIT's common stock
through the cash investment option of the Plan at 97 percent (subject to change)
of the average high and low market prices for the 12 days preceding the
investment date, as defined in the Plan.
Investors not yet participating in the Plan, as well as brokers and custodians
who hold IndyMac REIT common stock for clients, can get a Prospectus relating to
the Plan by contacting IndyMac REIT's Investor Relations Department at (800)
669-2300.
14
ITEM 6. SELECTED FINANCIAL DATA
(Dollar amounts in thousands, except per share data)
December 31,
---------------------------------------------------------------------------
1997 1996 1995 1994 1993
---------------------------------------------------------------------------
Operating Results for the Year
Interest income $ 360,901 $ 242,303 $ 180,465 $ 92,119 $ 65,504
Interest expense 242,372 159,365 131,910 66,700 65,312
---------------------------------------------------------------------------
Net interest income 118,529 82,938 48,555 25,419 192
Provision for loan losses 18,622 12,991 4,037 500 -
Equity in earnings of IndyMac 18,414 19,533 13,801 5,624 2,523
Other income 8,315 2,470 1,427 885 1,714
---------------------------------------------------------------------------
Total revenues 126,636 91,950 59,746 31,428 4,429
Salaries, general and administrative 21,935 14,202 4,213 2,402 1,549
Management fees to affiliate 4,406 8,761 5,522 1,195 400
Non-recurring charges 76,000 - - - -
---------------------------------------------------------------------------
Total expenses 102,341 22,963 9,735 3,597 1,949
---------------------------------------------------------------------------
Net earnings $ 24,295 $ 68,987 $ 50,011 $ 27,831 $ 2,480
===========================================================================
Per Share Data
Basic 0.43 1.51 1.25 0.86 0.13
Diluted 0.43 1.51 1.25 0.86 0.13
Dividends declared per share 1.79 1.52 1.25 0.87 0.48
Book value per share 11.11 9.53 8.55 7.99 7.83
Average Common Shares
Basic 56,125 45,644 39,903 32,184 18,578
Diluted 56,454 45,806 39,941 32,327 18,720
Shares Outstanding at December 31, 63,352 50,200 42,414 32,281 32,020
Balance Sheet Data At Year-End
Loans held for sale $ 1,458,271 $ 657,208 $ 409,584 $ 608,240 $ 794,132
Loans held for investment, net 3,290,311 1,948,291 1,744,611 975,633 -
Mortgage securities 558,445 231,780 124,975 121,441 -
Collateral for CMOs 245,474 289,054 184,111 233,690 402,503
Total assets 5,849,110 3,356,059 2,643,360 1,999,541 1,396,738
Short-term borrowings 4,826,656 2,531,509 2,037,834 1,534,189 770,334
Collateralized mortgage obligations 221,154 264,080 164,760 202,259 365,886
Senior unsecured notes 59,888 59,759 59,649 - -
Shareholders' equity 703,894 478,424 362,731 257,917 250,608
Operating Data(dollar amounts in millions)
IndyMac master servicing portfolio $ 12,400 $ 11,131 $ 9,419 $ 6,818 $ 1,977
Loans acquired 6,319 4,186 4,186 5,985 3,420
15
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
- -------------------------------------------------------------------------------
OF OPERATIONS
- -------------
GENERAL
INMC Mortgage Holdings, Inc., dba IndyMac Mortgage Holdings, Inc. ("IndyMac
REIT"), was incorporated in the state of Maryland in July 1985 and
reincorporated in the state of Delaware in March 1987. References to "IndyMac
REIT" mean either the parent company alone or the parent company and the
entities consolidated for financial reporting purposes, while references to the
"Company" mean the parent company, its consolidated subsidiaries and IndyMac
REIT's affiliate, IndyMac, Inc. ("IndyMac Operating") and its consolidated
subsidiaries, which are not consolidated with IndyMac REIT for financial
reporting or tax purposes.
In its mortgage loan conduit business, the Company acts as an intermediary
between the originators of mortgage loans and permanent investors in mortgage-
backed securities ("MBS") secured by or representing an ownership interest in
such mortgage loans. The Company purchases primarily "jumbo" and other
"nonconforming" mortgage loans from mortgage originators, and also purchases to
a much lesser extent subprime mortgage loans (i.e., "A- through D paper"
mortgages). The Company and its Sellers negotiate whether such Sellers will
retain, or the Company will purchase, the rights to service the mortgage loans
delivered by such Sellers to the Company. All loans purchased by IndyMac REIT,
for which a Real Estate Mortgage Investment Conduit ("REMIC") transaction or
whole loan sale is contemplated, are committed for sale to IndyMac Operating at
the same price at which the loans were acquired by IndyMac REIT pursuant to a
Master Forward Commitment and Services Agreement. At present, IndyMac Operating
does not purchase any loans from entities other than IndyMac REIT.
Additionally, the Company's conduit operations include the purchase or
origination, securitization and sale of consumer or mortgage loans for
manufactured housing and home improvements.
The Company's principal sources of income from its conduit operations are gains
recognized on the sale or securitization of mortgage and consumer loans, the net
spread between interest earned on mortgage and consumer loans and the interest
costs associated with the borrowings used to finance such loans pending their
sale or securitization, and servicing and master servicing fee income.
In addition to its conduit operations, the Company earns fee income and net
interest income through its construction and warehouse lending programs and net
interest income on its investment portfolio of mortgage and manufactured housing
loans and mortgage securities. Construction Lending Corporation of America
("CLCA") provides acquisition, development and construction, builder custom
home, model home, construction-to-permanent and lot loan financing on a
nationwide basis to builders, while IndyMac Construction Lending Division
("IndyMac CLD") provides the same products as CLCA to IndyMac Operating's third
party customers. Warehouse Lending Corporation of America ("WLCA"), the
Company's warehouse lending operation, provides financing to small-to-medium-
size mortgage originators for the origination and sale of mortgage loans.
On July 1, 1997, IndyMac REIT and Countrywide Credit Industries, Inc. ("CCR")
completed a transaction whereby IndyMac REIT acquired all of the outstanding
stock of its manager, Countrywide Asset Management Corporation ("CAMC"), from
CCR in exchange for 3,440,860 new shares of common stock of IndyMac REIT. The
transaction was approved in January, 1997 by a Special Committee consisting of
the independent directors of IndyMac REIT, by the full Board of Directors of
IndyMac REIT, and by the full Board of Directors of CCR. The transaction was
then approved by IndyMac REIT's shareholders at their Annual Meeting held on
June 24, 1997. Following consummation of the transaction, CAMC was merged into
IndyMac REIT, and IndyMac REIT became self-managed.
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IndyMac REIT accounted for this merger as the settlement of a management
contract for book purposes, which resulted in a non-recurring charge for IndyMac
REIT of $76 million during the third quarter of 1997. This charge did not
materially affect total shareholders' equity as $72 million represents a
reduction in retained earnings offset by a corresponding increase in common
stock and additional paid-in-capital. For tax purposes, the transaction
represents a tax-free exchange of shares with CCR, and the transaction did not
have a material effect on IndyMac REIT's taxable income. Accordingly, the
amount of the dividend and the tax status of IndyMac REIT's dividends were not
materially affected by the charge since the charge was taken for book purposes
only, not for tax purposes. For the year ended December 31, 1997, IndyMac REIT
had net earnings, prior to inclusion of the non-recurring charge, of $100.3
million, and basic and diluted earnings per share of $1.79 and $1.77,
respectively.
FINANCIAL CONDITION
CONDUIT OPERATIONS: During 1997, IndyMac REIT purchased $6.0 billion of non-
conforming mortgage loans, including $168 million of subprime mortgage loans.
In addition, the Company purchased $320 million of manufactured housing loans
and $82 million of home improvement loans. These loans were financed on an
interim basis using equity and short-term financing in the form of repurchase
agreements and other credit facilities. In general, the Company, through
IndyMac Operating, sells the loans in the form of REMIC securities or whole loan
sales or, alternatively, IndyMac REIT invests in the loans on a long-term basis
using financing provided by CMOs or repurchase agreements and other credit
facilities. During 1997, IndyMac Operating sold $3.4 billion of mortgage loans
through the issuance of thirteen series of multiple-class MBS in the form of
REMIC securities and sold $755 million of mortgage loans in the form of whole
loan sales transactions. At December 31, 1997, the Company was committed to
purchase $743 million of mortgage loans from various mortgage originators. The
IndyMac Operating master servicing portfolio at year-end had an aggregate
outstanding principal balance of $12.4 billion with a weighted average coupon of
8.5%. Delinquencies (30 days and over) for loans held for sale were 2.3% of
principal at December 31, 1997 compared with 5.0% at December 31, 1996.
RESIDENTIAL LOANS HELD FOR INVESTMENT: The $1.8 billion portfolio of
residential loans held for investment (exclusive of construction loans and
warehouse lines of credit) at December 31, 1997 consisted of $1.2 billion of
varying types of adjustable-rate products which contractually reprice in
monthly, semi-annual or annual periods; $473 million of loans which have a fixed
rate for a period of three, five, seven or ten years and subsequently convert to
adjustable-rate mortgage loans that reprice annually and $180 million of fixed-
rate loans. The weighted average coupon of the mortgage loans held for
investment at December 31, 1997 was 7.8%. The Company utilizes interest rate
swap agreements to manage the interest rate exposure on its portfolio of loans
held for investment. The Company finances loans held for investment with
repurchase agreements and other credit facilities which reprice from overnight
to one month, as of December 31, 1997. The allowance for losses related to
loans held for investment totaled $17.4 million at year end. Chargeoffs related
to loans held for investment totaled $7.2 million for the year ended December
31, 1997. Delinquencies (30 days and over) for loans held For investment were
6.3% of principal at December 31, 1997 compared with 8.7% at December 31, 1996.
CONSTRUCTION LENDING OPERATIONS: At December 31, 1997, CLCA had commitments to
fund construction loans of $1.3 billion, with outstanding principal balances of
$603.8 million. The allowance for losses related to CLCA loans totaled $6.9
million at December 31, 1997, and chargeoffs totaled $71,000 related to CLCA
loans for the year ended December 31, 1997. Delinquencies (30 days and over)
for CLCA were 0.9% and 0.5% of principal at December 31, 1997 and 1996,
respectively. The Company had outstanding borrowings under various revolving
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credit facilities totaling $270 million at December 31, 1997 associated with the
financing of CLCA loans.
At December 31, 1997, IndyMac CLD had commitments to fund construction-to-
permanent and home improvement loans of $603.7 million at December 31, 1997 with
outstanding principal balances of $343 million. The allowance for losses
related to IndyMac CLD loans totaled $328,000 at December 31, 1997, and there
were no chargeoffs for the year ended December 31, 1997. Delinquencies for
IndyMac CLD were 1.5% and 1.1% of principal, at December 31, 1997 and 1996,
respectively. The Company had outstanding borrowings under various revolving
credit facilities totaling $362 million at December 31, 1997 associated with the
financing of IndyMac CLD loans.
WAREHOUSE LENDING OPERATIONS: At December 31, 1997, IndyMac REIT had extended
commitments to make warehouse and related lines of credit in an aggregate amount
of $768 million, of which $512 million was outstanding, net of reserves. The
allowance for loan losses related to warehouse lines of credit totaled $1.8
million at December 31, 1997. There were no chargeoffs against such allowance
during the year ended December 31, 1997. Repurchase debt outstanding associated
with IndyMac REIT's financing of these warehouse lines of credit totaled $524
million at December 31, 1997. As of December 31, 1997 and 1996, there were no
delinquent (30 days and over) warehouse lines of credit.
CMO PORTFOLIO: As of December 31, 1997, IndyMac REIT had a portfolio comprised
of nine series of CMOs (the "CMO Portfolio"). Collateral for CMOs decreased to
$245.5 million at December 31, 1997 from $289.1 million at December 31, 1996.
This decrease of $43.6 million is primarily the result of repayments (including
prepayments and premium and discount amortization) of $43.2 million and a
decrease in guaranteed investment contracts ("GICs") held by trustees of
$400,000. IndyMac REIT's CMOs outstanding decreased to $221.2 million at
December 31, 1997 from $264.1 million at December 31, 1996. This decrease of
$42.9 million resulted from principal payments and discount amortization on CMOs
of $42.5 million and a decrease in accrued interest payable on CMOs of $400,000.
RESULTS OF OPERATIONS 1997 COMPARED TO 1996
NET EARNINGS: As a result of the non-recurring charge related to IndyMac REIT's
acquisition of CAMC, IndyMac REIT's net earnings were $24.3 million, or $0.43
basic and diluted earnings per share, based on 56,124,537 and 56,453,634
weighted average shares outstanding for 1997, respectively, compared to $69.0
million, or $1.51 basic earnings per share and $1.50 diluted earnings per share,
based on 45,643,885 and 45,805,509 weighted average shares outstanding for 1996,
respectively.
Earnings before the non-recurring charge related to the acquisition of CAMC were
$100.3 million, with $1.79 basic earnings per share and $1.77 diluted earnings
per share, respectively, for the year ended December 31, 1997.
The increase in net earnings of $31.3 million before the non-recurring charge
was principally due to an increase in net interest income of $35.6 million, a
decrease in management fees to affiliate of $4.4 million, and an increase in
other income of $3.9 million, offset, in part, by increases in the provision for
loan losses, salaries and general and administrative expenses of $5.6 million,
$4.9 million and $2.8 million, respectively.
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INTEREST INCOME: Total interest income was $360.9 million for 1997 and $242.3
million for 1996. The increase in interest income of $118.6 million was
primarily the result of increases in interest earnings on the following:
construction loans, $44.8 million; mortgage loans held for investment, $28.2
million; mortgage securities, $14.7 million; mortgage loans held for sale, $11.2
million; revolving warehouse lines of credit, $9.3 million; manufactured housing
loans held for sale, $6.9 million; advances to IndyMac Operating, $2.3 million;
home improvement loans held for sale, $1.7 million; and manufactured housing
loans held for investment, $1.4 million. These increases were partially offset
by a reduction in the interest income related to collateral for CMOs of $2.4
million.
Interest income on mortgage loans held for sale totaled $68.9 million and $57.7
million, resulting in effective yields of 8.5% and 8.8%, respectively, for the
years ended December 31, 1997 and 1996. The average principal balance of such
loans increased to $806.9 million for the year ended December 31, 1997, from
$659.2 million for the year ended December 31, 1996.
Interest income on manufactured housing loans held for sale totaled $9.2 million
and $2.3 million, with interest earned at effective yields of 9.7% and 9.8%, for
the years ended December 31, 1997 and 1996, respectively. The average principal
balance of such loans increased by $71.3 million to $94.5 million during 1997,
from $23.2 million for 1996. This increase is partly attributable to the
Manufactured Housing Division's commencement of operations in March 1996.
Interest income on mortgage loans held for investment totaled $122.5 million
during 1997 compared to $94.2 million during 1996. The increase from 1996 was
the result of an increase in the average amount of loans held for investment
during the year of $451.2 million partially offset by a decrease in the average
yield. The average principal balance of mortgage loans held for investment was
$1.6 billion during 1997 with interest earned at an effective yield of 7.6%,
compared to the average principal balance of mortgage loans held for investment
during 1996 of $1.2 billion with interest earned at an effective rate of 8.1%.
Interest income on manufactured housing loans held for investment totaled $2.7
million and $1.3 million, with interest earned at effective yields of 10.5% and
10.4% for the years ended December 31, 1997 and 1996, respectively. The average
principal balance of such loans increased by $13.0 million to $25.6 million
during 1997, from $12.6 million for 1996.
Interest income on construction loans totaled $75.0 million and $30.2 million,
with interest earned at an effective yield of 11.1% and 12.6% for the years
ended December 31, 1997 and 1996, respectively. The average principal balance
of construction loans outstanding increased $437.3 million to $677.6 million
during 1997 from $240.3 million during 1996.
Interest income on revolving warehouse lines of credit totaled $24.8 million and
$15.5 million, with interest earned at effective yields of 9.1% and 8.7% for the
years ended December 31, 1997 and 1996, respectively. The average principal
balance outstanding increased to $272.3 million from $177.6 million for the
years ended December 31, 1997 and 1996, respectively.
Interest income on mortgage securities totaled $25.3 million and $10.5 million,
with interest earned at effective yields of 7.3% and 8.1% for the years ended
December 31, 1997 and 1996, respectively. During 1997, the average principal
balance increased to $348.5 million from $129.5 million in 1996. Mortgage
securities consisted of senior securities, adjustable rate agency securities,
subordinated securities, principal-only securities, interest-only securities and
inverse floater securities. Interest-only securities were comprised primarily
of excess master servicing fees sold by IndyMac Operating to IndyMac REIT and
subsequently securitized by IndyMac REIT, which were classified and accounted
for as available for sale, and also include interest-only securities acquired by
IndyMac REIT in connection with the securitization of mortgage loans held for
sale by IndyMac Operating, which were classified and accounted for as trading
securities.
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Interest income on collateral for CMOs was $20.2 million and $22.6 million for
the years ended December 31, 1997 and 1996, respectively. This decrease was
primarily attributable to a decrease in the average aggregate principal amount
of collateral for CMOs outstanding to $267.0 million from $299.8 million for the
years ended December 31, 1997 and 1996, respectively. Interest income on
collateral for CMOs includes the impact of amortization of net premiums paid in
connection with acquiring the CMO Portfolio and the impact of the delay in the
receipt of prepayments and temporary investment in lower yielding short-term
holdings (GICs) until such amounts are used to repay CMOs.
INTEREST EXPENSE: For 1997 and 1996, total interest expense was $242.4 million
and $159.4 million, respectively. This increase in interest expense of $83.0
million was primarily due to an increase in interest expense on repurchase
agreements and other credit facilities of $86.1 million, offset in part by a
decline in interest expense on CMOs of $3.1 million..
Interest expense on repurchase agreements and other credit facilities used to
finance loans held for sale and investment, revolving warehouse lines of credit,
construction loans and mortgage securities totaled $217.5 million during 1997
compared to $131.4 million during 1996. This increase of $86.1 million was
primarily the result of an increase in the aggregate average balance of
indebtedness outstanding for the year to $3.5 billion in 1997 from $2.1 billion
in 1996. The effective interest rate on such borrowings was 6.2% and 6.3% for
the years ended December 31, 1997 and 1996, respectively.
Interest expense on CMOs was $19.4 million and $22.5 million for the years ended
December 31, 1997 and 1996, respectively. The decrease was primarily
attributable to a decrease in average aggregate CMOs outstanding to $243.9
million for 1997 from $275.0 million for 1996, combined with a decrease in the
weighted average cost of CMOs to 7.9% in 1997 from 8.2% in 1996.
Interest expense on senior unsecured notes totaled $5.5 million for each of the
years ended December 31, 1997 and 1996, respectively. The weighted average
interest rate of 9.2% and average outstanding balance of $59.8 million were also
the same for each of the years ended December 31, 1997 and 1996.
EQUITY IN EARNINGS OF INDYMAC OPERATING: The 1997 earnings for IndyMac Operating
of $18.8 million, in which IndyMac REIT has a 99% economic interest, resulted
principally from net interest income of $2.0 million and gain on sale of
mortgage loans and securities of $71.7 million, offset by salaries, general and
administrative expenses of $56.5 million, management fee expense of $0.7 million
and income taxes of $13.9 million. During 1996, earnings for IndyMac Operating
of $18.1 million resulted principally from net interest income of $2.5 million
and gains on sale of mortgage loans and securities of $51.7 million, offset by
salaries, general and administrative expenses of $31.2 million, management fee
expense of $2.1 million and income taxes of $13.5 million.
SALARIES, GENERAL AND ADMINISTRATIVE EXPENSES: The increase of $7.7 million for
the year ended December 31, 1997 compared to the year ended December 31, 1996 is
primarily the result of the increased personnel and expenses required to support
the growth in the operations of IndyMac REIT, including CLCA, IndyMac CLD, and
WLCA as well as the expense of putting in place certain administrative and
accounting functions as part of IndyMac REIT becoming self-managed.
MANAGEMENT FEES: For 1997, management fees were $4.4 million compared to $8.8
million for 1996. The decrease in the management fee was primarily due to
IndyMac REIT's aforementioned acquisition of its manager on July 1, 1997as a
result of which IndyMac REIT became self-managed and the management fee was
eliminated.
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RESULTS OF OPERATIONS 1996 COMPARED TO 1995
NET EARNINGS: IndyMac REIT's net earnings were $69.0 million, or $1.51 basic
earnings per share and $1.50 diluted earnings per share, based on 45,643,885 and
45,805,509 weighted average shares outstanding for 1996, respectively, compared
to $50.0 million, or $1.25 basic and diluted earnings per share, based on
39,902,680 and 39,941,433 weighted average shares outstanding for 1995.
The increase in net earnings is principally due to an increase in net interest
income and equity in earnings of IndyMac Operating of $34.4 million and $5.7
million, respectively, offset, in part, by increases in the provision for loan
losses and expenses of $9.0 million and $13.2 million, respectively.
INTEREST INCOME: Total interest income was $242.3 million for 1996 and $180.5
million for 1995. The increase of $61.8 million in interest income was
primarily the result of an increase in interest on the following: construction
loans, $23.6 million; mortgage loans held for sale, $23.0 million; warehouse
lines of credit, $5.5 million; collateral for CMOs, $5.4 million; mortgage
securities, $3.1 million; manufactured housing loans held for sale, $2.3
million; and manufactured housing loans held for investment, $1.3 million.
These increases were offset by a reduction in the interest income related to
mortgage loans held for investment of $3.5 million.
Interest income on mortgage loans held for sale totaled $57.7 million and $34.7
million, resulting in effective yields of 8.8% and 9.2%, respectively, for the
years ended December 31, 1996 and 1995. The average outstanding balance of such
loans increased to $659.2 million for the year ended December 31, 1996, from
$377 million for the year ended December 31, 1995.
Interest income on manufactured housing loans held for sale totaled $2.3 million
during 1996, resulting in an effective yield of 9.8% for the year ended December
31, 1996. There were no manufactured housing loans held for sale during 1995.
Interest income on mortgage loans held for investment, consisting primarily of
adjustable-rate mortgages, totaled $94.2 million and $97.7 million, resulting
in effective yields of 8.1% and 8.1%, for the years ended December 31, 1996 and
1995, respectively. The average balance of such loans outstanding decreased
slightly to $1.16 billion in 1996 from $1.21 billion in 1995.
Interest income on manufactured housing loans held for investment totaled $1.3
million during 1996. There were no manufactured housing loans held for
investment during 1995.
Interest income on construction loans totaled $30.2 million and $6.5 million
during 1996 and 1995, respectively. The average principal balance of
construction loans outstanding totaled $240.3 million during 1996, representing
an increase of $190.8 million from the average principal balance of $49.5
million during 1995. Interest was earned at an effective yield of 12.6% and
13.2% in 1996 and 1995, respectively.
Interest income on revolving warehouse lines of credit totaled $15.5 million and
$10.0 million with interest earned at an effective yield of 8.7% and 9.5% for
the years ended December 31, 1996 and 1995, respectively. The average principal
balance outstanding increased by $72.1 million to $177.6 million in 1996 from
$105.5 million in 1995.
Interest income on mortgage securities totaled $10.5 million compared with $7.4
million for the years ended December 31, 1996 and 1995, respectively. The
average outstanding balance of mortgage securities decreased slightly to $129.5
million in 1996 from $132.1 million in 1995. The yield on mortgage securities
increased to 8.1% in 1996 from 5.6% in 1995. Mortgage securities consisted of
subordinated securities, principal-only securities, interest-only securities and
inverse
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floater securities. Interest-only securities were comprised primarily of excess
master servicing fees sold by IndyMac Operating to IndyMac REIT and subsequently
securitized by IndyMac REIT, which were classified and accounted for as
available for sale, and also include interest-only securities acquired by
IndyMac REIT in connection with the securitization of mortgage loans held for
sale by IndyMac Operating, which were classified and accounted for as trading
securities.
Interest income on collateral for CMOs was $22.6 million and $17.3 million for
the years ended December 31, 1996 and 1995, respectively. The increase was
attributable to an increase in the average aggregate principal amount of
collateral for CMOs outstanding to $300 million for 1996 from $213 million for
1995, offset by a decrease in the effective yield earned on the collateral from
8.1% in 1995 to 7.6% in 1996. Interest income on collateral for CMOs includes
the impact of amortization of net premiums paid in connection with acquiring the
CMO Portfolio and the impact of the delay in the receipt of prepayments and
temporary investment in lower yielding short-term holdings (GICs) until such
amounts are used to repay CMOs.
INTEREST EXPENSE: For 1996 and 1995, total interest expense was $159.4 million
and $131.9 million, respectively. The increase of $27.5 million in interest
expense was the result of increases in the interest expense on repurchase
agreements and other credit facilities, collateral for CMOs, and senior
unsecured notes of $18.0 million, $4.9 million, and $4.5 million respectively.
Interest expense on repurchase agreements and other credit facilities totaled
$131.4 million during 1996 compared to $113.4 million during 1995. The increase
of $18.0 million was primarily the result of an increase in the aggregate
average balance of indebtedness outstanding for the year to $2.2 billion in 1996
from $1.7 billion in 1995, partially offset by a decrease in the weighted
average effective interest rate to 6.1% in 1996 from 6.7% in 1995.
Interest expense on CMOs was $22.5 million and $17.5 million for 1996 and 1995,
respectively. This increase was primarily attributable to an increase in average
aggregate CMOs outstanding to $275 million for 1996 from $185 million for 1995,
combined with a decrease in the weighted average cost of CMOs to 8.2% in 1996
from 9.5% in 1995. The increase in the average balance of CMOs was directly
related to the issuance of CMO 1996-1 in January, 1996.
Interest expense on senior unsecured notes totaled $5.5 million and $1.0 million
for the years ended December 31, 1996 and December 31, 1995 respectively. The
senior unsecured notes were issued in October 1995 at an effective rate,
including issuance costs, of 9.2%.
EQUITY IN EARNINGS OF INDYMAC OPERATING: The 1996 earnings of $18.1 million for
IndyMac Operating, in which IndyMac REIT has a 99% economic interest, resulted
principally from net interest income of $2.5 million and gain on sale of
mortgage loans and securities of $51.7 million, offset by operating expenses of
$31.2 million, management fee expense of $2.1 million and income taxes of $13.5
million. During 1995, earnings of IndyMac Operating resulted principally from
net interest income of $12.4 million and gains on sales of mortgage loans and
securities of $35.8 million, offset by operating expenses of $20.7 million,
management fee expense of $1.8 million and income taxes of $12.5 million.
SALARIES, GENERAL AND ADMINISTRATIVE EXPENSES: The increase of $10.0 million in
operating expenses for the year ended December 31, 1996 compared to the year
ended December 31, 1995 is primarily the result of the increased personnel and
expenses required to support the growth in the operations of IndyMac REIT and
its qualified REIT subsidiaries.
MANAGEMENT FEES: For 1996, management fees were $8.8 million compared to $5.5
million for 1995. The increase in the management fee was primarily due to an
increase in incentive compensation payable to CAMC in 1996, directly related to
the increase in IndyMac REIT's earnings during 1996 in comparison to 1995.
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LIQUIDITY AND CAPITAL RESOURCES
The Company's primary source of funds includes monthly principal and interest
payments on its investment portfolio, short-term borrowings, proceeds from the
sales of assets and issuance of REMIC and asset-backed securities, master
servicing fees and other servicing-related revenues and proceeds from the
Company's Dividend Reinvestment and Stock Purchase Plan ("DRIP"). Additionally,
the Company incurs certain charges to earnings, including amortization and
depreciation, loan loss provisions and unrealized losses on trading securities,
which do not require an outlay of funds. The Company believes these funds are
sufficient for growth of its lending activities, acquisition of investment
assets, repayment of short-term borrowings and the payment of cash dividends.
It is the Company's policy to maintain adequate capital and to comply with
leverage and other financial covenants set forth in the Company's debt
covenants.
The Company has entered into a repurchase facility with Merrill Lynch, Pierce,
Fenner & Smith Incorporated and certain of its affiliates, in an aggregate
committed principal amount of $1.0 billion. The agreement is committed for a
period of at least two years from the date of execution and currently permits
the Company to finance its mortgage conduit, mortgage portfolio, warehouse
lending, IndyMac CLD lending and manufactured housing lending assets and
operations. The repurchase facility carries a floating rate of interest based
on LIBOR, plus an applicable margin, which varies by the type of asset financed.
The Company is permitted to borrow additional uncommitted amounts under this
repurchase facility, and as of December 31, 1997, the total balance of
outstanding loans from Merrill Lynch was $3.6 billion.
The Company has entered into a repurchase facility with Nomura Asset Capital
Corporation in an aggregate principal amount of $300 million. Such repurchase
facility is committed for a two-year period from the date of execution and
currently permits the Company to finance its mortgage conduit, mortgage
portfolio, warehouse lending and consumer construction lending assets and
operations. This repurchase facility carries a floating rate of interest based
on LIBOR, plus an applicable margin, which varies by the type of asset financed.
The Company has entered into a repurchase facility with Paine Webber Real Estate
Securities, Inc. in an aggregate principal amount of $500 million. Such
repurchase facility is committed for a one-year period from the date of
execution and currently permits the Company to finance its mortgage conduit,
warehouse lending and mortgage portfolio assets and operations. Such repurchase
facility carries a floating rate of interest based on LIBOR, plus an applicable
margin, which varies by the type of asset financed.
In May, 1995, the Company entered into a two-year committed credit facility with
a syndicate of nine commercial banks led by First Union National Bank of North
Carolina. This facility primarily finances mortgage loans, construction loans,
and master servicing assets. In 1997, the Company amended this credit facility
to expand the number of lenders and the available committed borrowings from $405
million to $500 million. The interest rates under this credit facility are
based, at the Company's election, on LIBOR or the federal funds rate, plus an
applicable margin, which varies by the type of asset financed. On February 25,
1998, the Company amended this facility, by among other things, increasing the
available committed borrowings to $900 million, expanding the types of
collateral which can be financed thereunder and extending the term of the
commitment to three years.
During the fourth quarter of 1995, the Company raised $59.6 million in
connection with the private placement of senior notes with certain institutional
lenders. These senior notes are unsecured, and the proceeds are utilized by the
Company in connection with its working capital needs. The effective rate of
interest on such senior notes is fixed at 9.2% for a period of seven years from
the date of issuance. In 1995, the, the notes were rated "BBB-" by Duff &
Phelps Credit Rating Co.,
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and subsequently raised to "BBB" in 1997. At December 31, 1997, the notes were
rated "BBB " by Fitch IBCA Inc., and "BB+" by Standard & Poor's Rating Services,
Inc.
The Company has from time to time raised additional capital through secondary
public offerings, the most recent of which involved the issuance of the
Company's common stock with net proceeds totaling $68.7 million in February,
1995. The Company also raises new equity capital primarily through the optional
cash payment feature of its Dividend Reinvestment and Stock Purchase Plan.
During 1997 and 1996, the Company raised $206 million and $133 million,
respectively, through such Dividend Reinvestment and Stock Purchase Plan.
The Company has filed a shelf registration statement with the Securities and
Exchange Commission in an aggregate amount of $500 million which became
effective in January, 1998. Under the terms of the registration statement, the
Company is permitted to offer a variety of debt and / or equity instruments.
The Company has not determined what debt or equity instruments it may offer
pursuant to the shelf registration statement or when any such offerings may
occur.
The REIT provisions of the Internal Revenue Code restrict IndyMac REIT's ability
to retain earnings and thereby replenish the capital committed to its mortgage
portfolio, conduit operations, commercial lending and other operations by
requiring IndyMac REIT to distribute to its shareholders substantially all of
its taxable income from operations. Certain of the Company's material
businesses, including its mortgage conduit and commercial lending operations,
are known to require significant and continuing commitments of capital
resources.
Management believes that the Company's cash flow from operations and the
Company's existing financing arrangements are currently sufficient to meet the
Company's current short-term liquidity requirements. To the extent the Company
possesses working capital in excess of its current liquidity requirements, such
working capital is as a general matter utilized to repay borrowings under those
tranches of the Company's lines of credit which carry higher rates of interest,
which borrowings would typically remain available for reborrowing by the Company
pursuant to the terms and conditions of the applicable credit facility.
The Company's ability to meet its long-term liquidity requirements is subject to
the renewal of its repurchase and credit facilities and/or obtaining other
sources of financing, including issuing additional debt or equity from time to
time. Any decision by the Company's lenders and/or investors to make additional
funds available to the Company in the future will depend upon a number of
factors, such as the Company's compliance with the terms of its existing credit
arrangements, the Company's financial performance, industry and market trends in
the Company's various businesses, the general availability of and rates
applicable to financing and investments, such lenders' and/or investors' own
resources and policies concerning loans and investments, and the relative
attractiveness of alternative investment or lending opportunities.
CASH FLOWS
Operating Activities - During the year ended December 31, 1997, the Company's
operating activities required cash of approximately $820 million. The primary
operating activity for which cash was used during the year ended December 31,
1997 was the acquisition of mortgage loans and manufactured housing loans held
for sale.
Investing Activities - The primary investing activities for which cash was used
during the year ended December 31, 1997 were the acquisition of mortgage loans
held for investment, the purchase of mortgage securities and the funding of
construction loans receivable . The net cash used in investing activities
totaled $1.5 billion for the year ended December 31, 1997.
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Financing Activities - Net cash provided by financing activities amounted to
$2.4 billion for the year ended December 31, 1997. The cash provided by
financing activities was primarily the result of additional borrowings under
repurchase agreements and other credit facilities during 1997 and proceeds of
common stock issuances pursuant to the Dividend Reinvestment and Stock Purchase
Plan during the year ended December 31, 1997.
EFFECT OF INTEREST RATE CHANGES
Due to the characteristics of certain financial assets and liabilities of the
Company, and the nature of the Company's business activities, the Company's
financial position and results of operations may be materially affected by
changes in interest rates in various ways. With respect to its financial assets
and liabilities, the Company has devised and implemented a general
asset/liability investment management strategy which seeks, on an economic
basis, to mitigate significant fluctuations in the financial position and
results of operations of the Company likely to be caused by changes in market
interest rates. This strategy attempts, among other things, to balance
investments in various types of financial instruments whose values could be
expected to move inversely to each other in response to movements in market
interest rates. However, there can be no assurance that this strategy
(including assumptions concerning the correlation thought to exist between
different types of instruments) or its implementation will be successful in any
particular interest rate environment.
Financial assets of the Company that tend to increase in value as interest rates
increase, and decline in value as interest rates decrease would include
interest-only securities. These financial assets carry an implicit yield that
is based upon estimates of future cash flows on an underlying pool of mortgage
loans. As interest rates increase, the prepayments on the underlying pool of
mortgage loans tends to slow, resulting in higher residual cash flows than
would otherwise have been obtained, and therefore, results in higher implicit
yields. As of December 31, 1997, IndyMac REIT and IndyMac Operating on a
combined basis held $381 million of interest-only securities. Of the $381
million aggregate amount, $279 million of such assets are classified as trading
securities in accordance with the requirements of SFAS 115, since they were
acquired in connection with the securitization of loans held for sale by IndyMac
Operating.
Financial instruments of the Company that tend to decrease in value as interest
rates increase, and increase in value as interest rates decline, would include
REMIC senior securities, fixed rate subordinated securities, adjustable rate
agency securities, principal-only securities, US Treasury bonds and inverse-
floater securities. Similar to the interest-only securities, the principal-only
and inverse floater securities carry an implicit yield based upon estimates of
future cash flows on an underlying pool of mortgage loans. However, the
principal-only and inverse-floater securities generally sell at a discount,
similar to a "zero-coupon" bond, in order to yield an estimated return. If
interest rates increase and prepayments slow in comparison to assumed prepayment
rates, the repayment rate of the principal-only and inverse-floater security
would tend to lengthen and thus reduce the implicit yield on the security.
Conversely, if interest rates decrease, the rate of prepayment on the underlying
pool of loans would tend to increase, resulting in a more rapid rate of
repayment on the principal-only security and inverse floater security and
therefore a higher implicit yield. To a lesser extent, any mortgage securities
held by the IndyMac REIT or IndyMac Operating and supported by adjustable rate
mortgage loans may decline in value as interest rates increase, if the timing or
absolute level of interest rate adjustments on the underlying loans do not
correspond to applicable increases in market interest rates. As of December 31,
1997, IndyMac REIT and IndyMac Operating on a combined basis held $779 million
of REMIC senior securities, fixed and adjustable rate subordinated securities,
adjustable rate agency securities, principal-only securities, US Treasury bonds
and inverse floater securities. Of the $779 million aggregate amount, $359
million of such securities are classified as trading securities.
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In addition to the inherent risks in seeking to manage fluctuations in the value
of certain assets due to interest rate changes, there may be timing differences
in the recognition of the offsetting effects of gains and losses which are
attributable to specific instruments, depending upon whether a security is
classified as trading or available for sale. The unrealized holding gains and
losses on trading securities are recognized in earnings of the period for the
Company. By comparison, the unrealized holding gains and losses of securities
available for sale are excluded from earnings of the Company and included as a
separate component of shareholders' equity. Therefore, to the extent that the
Company is required under GAAP to classify certain securities as trading, such
identification and the resulting accounting could cause additional volatility
in the Company's future reported earnings in periods where interest rates
fluctuate.
The Company is also subject to certain business and credit risks in connection
with interest rate changes. Increases in interest rates may discourage
potential mortgagors from borrowing or refinancing mortgage or manufactured
housing loans, thus decreasing the volume of loans available to be purchased
through the Company's conduit operations, or financed through the Company's
construction and warehouse lending operations. Additionally, with respect to
adjustable rate loans, the rate of delinquency may increase in periods of
increasing interest rates as borrowers face higher mortgage payments.
The Company's liquidity position and net interest income could also be adversely
impacted by significant interest rate fluctuations. Each of the Company's
collateralized borrowing facilities described above in Liquidity and Capital
Resources permits the lender or lenders thereunder to require the Company to
repay amounts outstanding an